The internet advisor rule was initially adopted in 2002 but has since been widely abused by many firms that did not meet the eligibility requirements for the exemption. To address this issue, the SEC is introducing a new rule that aims to ensure that only qualified advisors can take advantage of this exemption. After implementing new rules, the SEC will conduct targeted examinations to verify firms' compliance with the regulations.

According to SEC staff, some firms have been misusing the internet exemption because their websites lacked interactivity or because they had too many clients that advisors directly worked with.

The proposed updates to the exemption criteria, discussed during the SEC's July meeting, seek to tighten regulations at a time when robo-advisory technology is becoming increasingly popular and firms are expanding their online services.

SEC Chairman Gary Gensler highlighted the significance of the new rule by stating, "If adopted, it would help modernize a 21-year-old rule to better protect investors in a digital age."

Internet Advisor Exemption: Reforming the Rules

The internet advisor exemption was initially implemented to cater to small online firms that do not manage enough assets to necessitate federal registration. Traditionally, smaller firms (those with less than $100 million in assets) were required to register with a state securities regulator. However, online-only shops, operating without any physical operations, had to contend with multiple state registrations based on their client base. In an effort to alleviate the compliance burden for qualifying firms, federal registration was introduced, resulting in 845 firms actively utilizing this exemption since its inception.

However, recent observations by the SEC have shed light on the misuse of this exemption by numerous firms. The Commission's staff meticulously documented these findings in a 2021 risk alert, which summarized the results of examinations conducted on firms employing robo advice services.

Shockingly, the risk alert revealed that nearly half of the advisors who claimed to rely on the internet advisor exemption were actually ineligible to do so. This disconcerting trend has persisted for several years.

To rectify this situation, the SEC has proposed new rules that are now open to public commentary. One significant change is that only advisors who exclusively provide advice through their online channel would be eligible for the exemption. Currently, firms with fewer than 15 non-internet clients can still qualify for the internet advisor exemption.

Additionally, the SEC stipulates that only firms with a continuously operational and interactive website, catering to more than one client, would be eligible. This provision allows for temporary service downtimes due to scheduled maintenance or unforeseen outages, including cyberattacks.

The consensus among the commissioners is that these rules are long overdue for an update, particularly given the persistent abuse of the exemption by a specific subset of Registered Investment Advisors (RIAs).

The Misuse of the Exception

Commissioner Caroline Crenshaw has expressed concern over the chronic misuse of the exception. Initially designed to serve a specific purpose, it has now become widespread and taken advantage of by noncompliant advisors. These advisors have cleverly evaded multiple state registrations and have utilized registration with the commission to create an illusionary sense of agency approval.

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